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May 21, 2007

MOSCOW. (Ian Pryde for RIA Novosti) - Much attention this week was focused on the visits to Moscow by the German and US foreign ministers and the Russia-EU summit in Samara.

The arrival of an IMF delegation and changes in Russia's budget process went largely unnoticed, and yet they shed an interesting light on the profound changes of recent years.

Russia's economy seems to be awash with money, and at first sight the country has never had it so good.

This week, the Central Bank of Russia announced that between 4 and 11 May 2007, Russia's gold and foreign currency reserves had increased by $14.2 billion to $386.3 billion, making them the third largest in the world, although they remain far lower than China's figure of over $1 trillion.

On preliminary figures, Russia's budget surplus in the first quarter of 2007 was 471.9 billion rubles ($18.2 billion).

It is of course no secret that Russia's economy has recovered on the back of high oil and gas prices, although other commodities such as coal, metals and timber are important and arms sales and machinery also contribute to Russia's exports.

The real questions are how to manage all this money and at the same time ensure Russia's economic diversification and continued growth.

Russia is coping with the first task rather better than the second.

It has paid back its sovereign debt to the Paris Club, saving billions of dollars a year in interest payments, and no longer needs to go cap in hand to the IMF for periodic bailouts as happened during much of the 1990s.

Russia has set up a Stabilization Fund on the lines of Norway and other countries to soak up petrodollars and prevent the Dutch disease: by April 1, 2007, the Fund had reached 2.8 trillion rubles ($108.02 billion) and inflation has been falling, although it is still too high.

Russia's finance ministry is replacing the annual budget plan with a new three-year budget to cover 2008-10 with the aim of stabilizing and rationalizing the country's finances and expenditures.

Pointing to the successful experience of other countries using this approach, the hope is that departments will be able to allocate money more effectively over a three-year period, rather than having to return unused money to the government at the end of the financial year as under the current system.

All of this has been made possible by the favorable external economic environment.

But this manna from heaven has not yet led to real diversification in the economy, and manufacturing and services remain underdeveloped.

Moreover, despite growth averaging over 6% per annum since 2000 and a veritable consumer boom based on oil and credit, Russia is only now recovering to the output levels of the early 1990s following what many see as the biggest collapse in an economy during peacetime in the 20th century.

President Putin and the government are of course aware that the economy is far too dependent on commodities, and that economic growth over the next few years would no longer be driven by oil to the same extent as earlier.

The Kremlin has also been emphasizing for some time now that more processing of its huge raw materials must be done in Russia in order to export higher value added products in industries such as oil and timber.

It is also keen to develop high-tech areas such as nanotechnology and is investing in a series of science parks across the country.

The government is setting up investment and venture funds to help finance these areas, but it remains to be seen how all of this will be implemented in practice.

The national projects introduced by the Kremlin in 2005, aimed at improving the country's education, agriculture and providing affordable housing, for example, have not resulted in huge spending programs.

And as Putin said this week, the housing sector is characterized by "very high" corruption - which in the Russian context is a damning indictment, although hardly front-page news.

The president also speaks of the need to develop a middle class, and yet corruption, bureaucracy and onerous laws are widely seen as inhibiting the country's economic development by placing too great a burden on small and medium-sized enterprises.

Comparisons are always risky, but Tony Blair's recent announcement of his forthcoming resignation as British Prime Minister highlights the problems of achieving real improvement in public services through government intervention in one of the richest countries in the world.

Most agree that Britain's huge investment in health and education over the last 10 years have failed to produce the desired and expected results.

The weakness of Russia's banking and transport infrastructure are also areas where future bottlenecks are likely.

Russia might have paid back its sovereign debt, but commercial debt has been rising fast, leading some observers to point to the risk of a future banking crisis due to the high level of non-performing loans.

And although the government wants to attract much-needed foreign investment, its approach is unlikely to bring in the vast amounts required.

This Friday, Sergei Ivanov, deputy prime minister and widely tipped as a possible future president, said that Russia would put in place incentives to attract foreign investment.

But these proposals repeat the very same mistake as the first laws on joint ventures with foreign companies which Mikhail Gorbachev put forward in the late 1980s - money would be welcome, but the Soviet enterprises would be in control.

Twenty years on, it is Russian companies that will remain in charge.

So Russia seems to have missed a good opportunity in recent years to reform the economy, while the weakness of the state raises questions about how far the government could implement any such program.

Key policy changes to address these issues would make a major difference, but it seems that the government is reluctant to embrace them at the moment.

Despite the rhetoric of recent months, however, Russia did have a good piece of news on the economic front this week.

Although Moscow's attempt to joint the World Trade Organization has been fraught with difficulties, ministers from the 30 members of the Organization for Economic Cooperation and Development (OECD), the Paris-based club of rich countries, said that they would begin talks on membership with Russia, as well as with Chile, Estonia, Israel and Slovenia.

Ian Pryde is CEO of Eurasia Strategy & Communications, Moscow.

The opinions expressed in this article are the author's and do not necessarily represent those of RIA Novosti.

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